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One Easy Proven Method for Tactical Asset Allocation

|Includes:EFA, GSC, IEF, IFNA, SPDR S&P 500 Trust ETF (SPY)

In these times of market uncertainty, we continue to read how the old models have broken down - and yet there are too many new models to choose from - all unproven. Summing up this dichotomy among points of view is one of the best articles I've read lately: Roben Farzad in BusinessWeek last month - "Searching for True North."  In the end, though, we still lack a north star for navigating today's market.

Or do we? Perhaps Mr. Farzad is unfamiliar with the work of Mebane T. Faber of Cambria Investments. Mr. Faber published a paper in The Journal of Wealth Management back in 2004, entitled "A Quantitative Approach to Tactical Asset Allocation." He updated the paper early in 2009 with data through the end of 2008's market cataclysm.

The results are impressive: from Jan 1 1973 through Dec 31 2008, Faber's tactical model averaged 11.27% annual returns (before fees) and lost money only one year, 2008. Guess what the loss was? Less than 1%. Faber's model outperformed a comparable buy-and-hold model by an average of 1.5% per year.

As impressive as the returns are, what really impressed me are three other attributes of this model: 1) it only evaluates the portfolio once a month; 2) it only holds 5 investments; and 3) the buy/sell discipline is entirely mathematical, removing human judgement (and error) from the equation.  In other words, this model is extremely fast and easy to implement and maintain in almost any portfolio.

The model starts with an equal allocation of 5 indexes: S&P 500 (NYSEARCA:SPY), MSCI EAFE (NYSEARCA:EFA), S&P Goldman Sachs Commodity Index (NYSEARCA:GSC), NAREIT (NASDAQ:IFNA), and 10-year treasuries (I approximate using IEF).

The buy/sell discipline evaluates the price of each investment once-a-month against its 10-month simple moving average. If the price of the security is above its 10-month SMA, then it is time to buy in or stay invested at 20% of the portfolio. If the price of the security drops below the 10-month SMA, then it is time to sell the entire position and hold cash (money market) until the security price once again crosses over the 10-month SMA.

Any readers interested in more information can download Faber's paper from the Social Science Research Network or my web page, Grin Press.

I'd enjoy hearing from fans or critics of Faber's work.

Disclosure: Long all of: SPY, EFA, GSC, IFNA, IEF.

Stocks: SPY, EFA, GSC, IFNA, IEF